Support and Resistance: How To Apply Technical Analysis in Trading
Technical analysis (TA) is a method of forecasting the direction of prices through the study of past market data. It is based on mathematical and statistical methods, with some practitioners using charts to identify patterns in price trends.
TA involves looking at the market price and trading volume and the timing of trades to predict future trends.
What are Support and Resistance Levels?
The Support and Resistance levels are one of the most common technical indicators used in TA. They are levels where the price often visits and where the most significant market activity occurs, which could signal the next direction, whether it’s a bullish or a bearish market.
Support: the level at which the price stops with a large demand for the coin/token.
Resistance: the level at which the price stops rising with a large volume of supply of the coin/token flooding the market.
The main difference between support and resistance is in the direction of price. The more times the price has performed that behavior at these technical levels, the “easier” or more probable it will be to predict the price movement in the future.
Support and resistance levels are considered psychological levels; that is, traders tend to buy or sell at those points, which helps to strengthen them.
What is the use of identifying Support and Resistance?
1. To project the next direction of market price
The price will tend to move between support and resistance, slowing down when approaching these levels, where sometimes they act as a support when the market is bullish and resistance when the market is bearish.
2. To determine where to place your stop-loss
Stop-loss is a type of order that lessens the risk and closes the losing position of a trader. They’re usually placed below support or above resistance, where we do not expect the current market price to hit.
Bullish traders who are “long” on a coin/token will put their SL below the support in an area with the least probability of hitting, and bearish traders who are “short” on a coin/token will put their SL above the resistance and the current market price.
It is best to know what type of stop-loss orders to use in different situations.
A market-order type of SL will only be triggered when the current market and index price hit the level you set your order and when there is sufficient liquidity for the market.
A limit-order type of SL will provide liquidity in the trading pair and will be triggered regardless if the market is liquid or not.
A trailing-stop order will be triggered if the price suddenly triggers your pre-determined price level that is also moving with the current price (e.g., 1% below the current price).
3. To know how far we have to wait before entering a position
It is always good to wait for the price to approach its local lows or highs. Sooner or later, the price will come with significant support or resistance, which presents the best opportunity to buy or sell your coin/token.
The more times the support level is tested and quickly regains, the more significant demand enters the market and vice versa.
4. To recognize channel breakouts and be prepared for any price breakout
It is common for the price to shoot out after retesting the S/R levels and a channel breakout. If you have marked these levels correctly, you will know precisely when the price leaves the channel, and you’ll be able to anticipate it by placing conditional entry orders just outside the channel.
How to Calculate Support and Resistance?
To accurately detect support and resistance on a chart, we must take into account the following aspects:
- Support and resistance are nothing more than “hard” levels where the price consolidates before continuing or reversing the current trend.
- The easiest way to locate support/resistance is to look for levels where price stops or rebounds. A very defined price does not always determine support and resistance. Sometimes, they are more like price bands.
- The relevance of this indicator increases over a longer time frame because it takes into account more market data. Longer time frames from Yearly, Monthly, Weekly, and Daily take precedence over Hourly and on a lower time duration. The more frequent this pattern shows in higher time frames, the more probable it will behave in the future.
Here are some examples of Support and Resistance of the Bitcoin chart from the lower to higher time frames:
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Disclaimer: This article is for educational purposes only and must not be treated as financial or legal advice.
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